Evaluate two ways that the government could increase the competitiveness and contestability of the

smartphone market.

The smartphone market is a highly concentrated market with little contestability and only some competition. The
three largest firms, apple samsung and huawei comprise 69% of the market share, demonstrating that this market
is an oligopoly, an industry with many small large sellers that are interdependent on one another’s actions. In this
case, R&D tax breaks as well as subsidising new entrants could increase both the contestability and the
competitiveness of the market.

A subsidy, a grant given to suppliers to encourage an increase in production, could increase the competitiveness of
the smartphone industry because they would reduce costs of production for new entrants, meaning that they could
lower their prices and compete with incumbent firms that are dominating the market. The government may
subsidise new entrants because incumbent firms like apple, with 30% market share, act as legal monopolies and
restrict output whilst raising price. This means that the smartphone industry is uncompetitive as apple has such a
large market share that it can set high prices but still have customers. In order to improve the competitiveness of
this market, the government could give new entrants subsidies. These subsidies could be spent on sunk costs like
rent for the smartphone factories, reducing the barriers to entry and increasing contestability. Moreover, these
subsidies would reduce costs of production significantly from AC to MC1, leading to lower prices but also an
increase in output. This increase in output could lead to further economies of scale meaning that new entrants
could now benefit from purchasing economies of scale, making it easier for them to buy phone parts in bulk,
significantly lowering their long run average costs and reducing their prices even further to P1. These decreases in
prices increase the competitiveness as consumers will begin to leave monopolists like Apple and Samsung and
demand phones from Huwaei. In order to retaliate, the incumbent firms may also lower their prices to try and win
consumers back so the prices of all phones in the industry will decrease meaning there has been an increase in
competitiveness. This has been seen in China, with the government providing subsidies to help Huawei lower its
unit costs and compete with Apple and Samsung globally. Now, Huawei has 13% of the total market share in the
smart phone industry

However, subsidising new entrants may not help to increase the contestability and competition within the
smartphone industry. Firstly, subsidising new firms does not address the structural issue, which is that large
phones like Apple and Samsung have huge brand loyalty and this acts as a barrier to entry in the market because
even if Huawei enters with low prices, consumers have Price inelastic demand for iphones and samsungs so they
will not begin to demand Huawei’s phones. Moreover, in the short run, apple and samsung may not decrease their
prices closer to P=MC, and therefore competitiveness of the market may not increase because their customers are
on fixed contracts so they will only be able to switch to Huawei in the long run if they want to avoid paying high
fees.
On the other hand, the government could allow for R&D tax breaks in order to increase the
competitiveness and contestability of the market. R&D tax breaks are reductions in taxes in order to
allow companies to reinvest their profits into research and development with the hope that the final
product will improve in quality. In this case, if the government allowed tax breaks for smaller
smartphone companies like Lenovo, it would allow Lenovo to improve the quality of their products or
to reduce their prices. If Lenovo had more money to spend on R&D they could research how to
improve the ergonomics of their smartphones or conduct surveys into which smartphone features
consumers want. This would then allow them to focus on improving these features and eventually
they would have a better quality product, increasing the demand for their smartphones and
decreasing the concentration ration within the market. Furthermore, if they use the breaks to reinvest
into better capital like faster or more accurate CNC machines then the productivity would increase as
they are now producing more phones than before in a given time period. Consequently, their costs
would fall and prices would decrease to P1. These lower prices means that Huawei can compete with
the much larger firms within the market which they were unable to do previously meaning that
competitiveness has increased.

However, R&D tax breaks may not lead to increased competition within the smartphone industry
because new entrants may not use these breaks to invest into RnD and may instead keep the
increased profits for themselves. Furthermore, if these tax breaks are small it may not leave enough
profit for Huawei to invest into improving the quality of their products. As firms in oligopolies are
interdependent on each other’s actions, Apple may retaliate against Lenovo’s non-price competition
by using its huge profits to invest into far greater levels of R&D than Lenovo which would mean that in
the long run apple’s products would remain far better quality than Lenovo and the competitiveness
would not increase, this has been seen in recent years with apple’s cross-subsidisation into Airpod
Pros and even virtual reality. They may even retaliate with predatory pricing past AC=AR if they felt
threatened by Lenovo and this could force Lenovo out of the market reducing its competitiveness and
contestability. In order for Lenovo or other small smartphone makers to compete, the R&D breaks
would have to be substantial and it is unlikely that they have enough profit to effectively invest into
research and development.

In conclusion, a subsidy would be most effective at increasing the contestability and competitiveness
of the smartphone industry because it would help to lower the largest barrier to entry, economies of
scale, and would help new entrants to compete with incumbent firms on price. However, it depends on
the behaviour of the incumbent firms as a subsidy will be ineffective if the incumbent firms predatory
price.